A confusing 'deal' between the U.S. and Mexico

U.S. President Donald Trump announced last week that negotiators had reached a deal with Mexico to replace the North American Free Trade Agreement (NAFTA), a pact that he has repeatedly denounced as flawed and harmful to the United States. The new deal does not include Canada, the third member of NAFTA. Trump insists that while Canada can join the new arrangement, he can proceed without Ottawa, a questionable assertion. Either way, Trump has created substantial uncertainty regarding trade in North America and that will unnerve businesses looking for stable, predictable outcomes on which to base investment decisions.

Trump has long dismissed NAFTA as “the single worst deal ever approved,” arguing that it prompted U.S. businesses to export manufacturing jobs to Mexico in search of low-cost labor, gave foreign businesses a platform to export to the U.S, and allowed Canada to shield parts of its economy from U.S. competition. During the 2016 campaign he promised to repeal and replace it with something better, and after being elected he threatened to withdraw from the agreement, a move often seen as a negotiating tactic.

Negotiations were slow, and progress was impeded by a war of words that erupted this summer between Trump and Canadian Prime Minister Justin Trudeau, whom the U.S. president now sees as a foil. As a result, U.S. negotiators focused on a bilateral deal with Mexico, the contours of which were announced last week.

That agreement raises the domestic (i.e., NAFTA) content requirement for automobiles from 62.5 percent to 75 percent. In addition, at least 40 percent to 45 percent of auto content would have to be made by workers earning a salary of at least $16 per hour (which would give manufacturers less reason to outsource labor to Mexico). The deal would have a 16-year life span, with a review every six years for another 16 years. Finally, the new pact eliminates dispute settlement panels for certain anti-dumping cases.

There are a number of problems with “the deal.” First, it is a bare outline that does not address many NAFTA provisions. (Curiously, the fact sheet is no longer available on the U.S. Trade Representative’s website.) Second, more significantly, it is not clear if the president can conclude a deal without Canada. Trump has legal authority to negotiate an agreement with the three NAFTA countries. Failure to include Ottawa suggests that this a different deal. Trump has warned that if he cannot conclude this agreement, he will withdraw from NAFTA, but again it is not clear if he has the authority to do so: That power may belong to Congress.

An important issue is timing. Congress requires 90 days to assess a deal and Mexico’s president, Enrique Pena Nieto, leaves office Dec. 1. Trump wants to wrap up the deal before Nieto steps down, as he is not sure how his successor, a more populist leader, will treat the agreement; in theory, he could reopen talks when he becomes president. Canada could still be part of the agreement that Congress debates — the administration has 30 days to submit a final text — but talks between the U.S. and Canada have made no progress and Trump has further complicated matters by insisting he will make no concessions to Ottawa, goading Canadian negotiators over the weekend with public statements to that effect.

Trump is gambling that a strong stand against the existing NAFTA will pay political dividends. He is focused on disaffected voters in the 2018 midterms, especially blue-collar workers who voted for him in 2016. He is also betting that Canada, which sends 75 percent of its exports to the U.S. and has 2.5 million jobs dependent on trade with the U.S., will fold. He does not seem to recognize that 8 million U.S. jobs are supported by trade with Canada and it is the top U.S. export destination.

Japanese companies are watching this spectacle with trepidation. The U.S. market accounts for one-third of global vehicle sales by Japan’s top three automakers (Toyota, Nissan and Honda). All three have factories in the U.S., but they also produce vehicles in Mexico, and Toyota and Honda operate plants in Canada. Changing content rules will force them to adjust manufacturing and assembly supply chains.

Even if he does not conclude a deal, Trump could “win.” Confusion and uncertainty can be avoided if businesses reduce the length of their supply chains and just invest in the U.S. That is a sub-optimal economic strategy, but it makes political sense. If that is Trump’s intent then it is devious — and short-sighted. Other governments could copy his tactics to force U.S. companies to invest in their countries to maintain their international markets. It is a recipe for a real trade war, one with potentially devastating consequences.